A deferred payment situation occurs when the seller delivers goods and services, but then time passes before the customer pays for them. A "fly now, pay later" plan is an example of this situation, as are the so-called "0% financing" plans that some auto dealers use as customer incentives.
By contrast, the prepayment situation occurs when a buyer pays first and then a significant time passes before the seller delivers delivery of goods and services. Tenants typically pay floor space rental fees, for instance, at or before each occupancy period. Insurance companies typically require premium payment before the coverage period starts. Rental expense and insurance premiums paid this way are thus prepayment situations for the buyer.
Explaining Deferred Payment and Prepayment in Context
Sections below further define and explain deferred payment and prepayment in context with related terms from accrual accounting, including the following:
- What are deferred payment and prepayment?
- How are deferred payment and prepayment related to other accounting concepts?
- Does the deferred payment and prepayment concept exist in cash basis accounting?
For any company on a cash basis accounting system, however, the bookkeeping practice is much simpler. In cash basis accounting:
- Expenses are recognized when cash is paid
- Revenues are recognized when cash is received.
Deferred expenses (prepaid expenses, or deferred charges) along with the other prepayment and deferred payment situations described above, are accrual accounting concepts. These concepts simply do not exist in cash basis accounting.